On 13 August, Justice Nye Perram handed down his landmark decision on the boundaries of responsible lending obligations in Australian Securities and Investments Commission v Westpac Banking Corporation (No 2)  FCA 751. The case, brought by the Australian Securities and Investments Commission (ASIC) as a 'test case' has received a high level of media coverage, especially in the context of ASIC's proposed updates to its responsible lending guidance and in light of the Financial Services Royal Commission.
The National Consumer Credit Protection Act 2009 (Cth) (NCCP Act) requires lenders to assess whether loans will be unsuitable for consumers. The litigation related to Westpac’s home loan assessment process during the period December 2011 and March 2015, during which approximately 260,000 home loans were approved by Westpac’s automated decision system.
ASIC alleged that Westpac breached its responsible lending obligations under the NCCP Act because its automated decision system:
- did not have regard to consumers' declared living expenses when assessing their capacity to repay home loans (instead relying on the Household Expenditure Measure (HEM)); and that
- Westpac used the incorrect method when assessing a consumer’s capacity to repay a home loan at the end of the interest-only period. ASIC alleged that Westpac was required to have regard to the higher repayments at the end of the interest-only period in assessing home loans of this kind but, did not do so.
Justice Perram rejected ASIC's case on both grounds
Why did ASIC's case fail?
ASIC's case failed on the first ground both on the facts 'and as a matter of statutory construction'
On the first ground, Perram J rejected ASIC's case on the basis that as a matter of fact, 'Westpac did have regard to…declared living expenses'. Justice Perram on to observe that even if this were not so, 'the Act does not operate as ASIC alleges'.
No requirement to use a prospective borrower's declared living expenses
Justice Perram observed that 'the Act requires a credit provider to ask itself only whether "the consumer will be unable to comply with the consumer’s financial obligations under the contract" or, alternatively, whether the consumer "could only comply with substantial hardship" [the s 131(2)(a) Questions]. Further, though the Act 'requires a credit provider to ask the consumer about their financial situation (s 130(1)(b)) and, in turn, to ask itself—and to answer—the s 131(2)(a) Questions' there is no 'further consequence that the credit provider must use the consumer’s declared living expenses in doing so'.
In fact, Perram J observes that the Act is 'silent on how a credit provider is to answer the s131(2)(a) Questions. The Act 'contains neither an express statement that a credit provider must use the consumer’s declared living expenses in doing so nor, in my opinion, can such a requirement be discerned from its terms as a matter of necessary intendment'.
Justice Perram went on to state that the only way that one or more declared living expenses can be shown to be necessarily relevant to the issue of whether the consumer can afford to make the repayments is by identifying some living expenses 'which simply cannot be foregone or reduced beyond a certain point'. In illustration, Perram J observed, 'I may eat Wagyu beef everyday washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare. Knowing the amount I actually expend on food tells one nothing about what that conceptual minimum is. But it is that conceptual minimum which drives the question of whether I can afford to make the repayments on the loan'.
Ultimately, Perram J took the view that 'A credit provider may do what it wants in the assessment process, so far as I can see; what it cannot do is make unsuitable loans. ASIC’s argument creates a whole new range of implied rules which appear altogether unnecessary'.
Use of the Household Expenditure Measure (HEM) benchmark?
ASIC did not allege that Westpac was entirely prohibited by the NCCP Act from using the HEM benchmark in assessing whether a loan was unsuitable (ie answering the s 131(2)(a) Questions). Rather, ASIC's case was that Westpac was obliged not to place sole reliance on it (and instead was required to take into account the consumer's declared living expenses). Given Justice Perram's rejection of this view, he observed that the use of the HEM 'was of marginal relevance' by the conclusion of the trial.
'ASIC is either right or wrong in its contention that Westpac was obliged to base its assessment of unsuitability on the consumer’s declared living expenses. If ASIC is right about that, it is irrelevant whether the HEM benchmark is a good, bad or indifferent proxy for substantial hardship because, regardless, this can have no impact on the fact that Westpac failed to take into account any of the declared living expenses. If, on the other hand, ASIC is wrong about that, the qualities of the HEM benchmark also do not matter because they have no impact on the result. This is because ASIC will, on that hypothesis, already have failed. Consequently, the capacity of the HEM benchmark to serve as a proxy for substantial hardship is not an issue which is actually live in the litigation' Perram J states.
Justice Perram went on to say that could see 'no utility in resolving the issue. Beyond the fact that the HEM benchmark appears to be a mechanism for assessing hardship and Westpac thought it to be such, I see no relevance to this material'.
ASIC's case also failed on the second ground
Justice Perram also rejected ASIC's argument that Westpac breached the NCCP Act in the manner in which it answered the s 131(2)(a) Questions in the case of loans having an initial interest only period before payment of principal was required.
'Westpac’s legal obligation was to ask and answer the s 131(2)(a) Questions. The fact that it did so as if the loan did not involve an initial interest only period does not mean that it did not ask and answer those questions. ASIC alleges that Westpac contravened the Act in this way on 154,351 occasions across the same period as its first allegation (these loans are a subset of the 261,987 loans which figure in ASIC’s primary case). ASIC’s case on these loans fails too' Perram J found.
Westpac has welcomed the clarity provided by the decision
In a short statement, Westpac acknowledging the responsible lending ruling Westpac Chief Executive (Westpac Consumer Division) David Lindberg, said: 'Westpac has always sought to lend responsibly to customers and takes its lending obligations very seriously. This is an important test case for the industry, and we welcome the clarity that today’s decision provides for the interpretation of responsible lending obligations'.
The statement adds that 'Westpac aims to build and maintain constructive and trusted working relationships with its regulators, including when we have a genuine difference of opinion. When this occurs, our preference is to resolve the difference in an open, transparent and respectful way'.
ASIC's response: 'as a regulator, it is our role to test the law and its ambit'
In a statement, ASIC Commissioner Sean Hughes said that 'ASIC took on the case against Westpac because of the need for judicial clarification of a cornerstone legal obligation on lenders, this is why ASIC refers to this case as a "test case". As a regulator, it is our role to test the law and its ambit. The obligation to assess loan applications builds on the requirement for banks to make inquiries about a borrower’s financial circumstances and capacity to service a loan and to verify the information that borrowers give banks'. He added that 'ASIC is reviewing the judgment carefully'.
Commenting on the impact of the decision on ASIC's proposed updates to its responsible lending guidance, The AFR quotes Mr Hughes as saying that he does not believe that the decision 'in and of itself in any way undermines our [ASIC's] additional guidance and if anything cements why we need guidance in the first place'.
Broader Context: ASIC's proposed updates to its responsible lending guidance
On 14 February, ASIC released proposed changes to responsible lending guidance (CP 309 Update to RG 209: Credit Licensing: Responsible Lending Conduct) for consultation. Consultation closed on 20 May (see: Governance News 20/02/2019). ASIC subsequently released submissions received in response to the consultation paper and announced that it would hold public hearings (12 August and 19 August) to 'robustly test' some of the issues/views raised in submissions.
A number of submissions raised concerns about ASIC's proposed approach. The Australian Banking Association raised concerns that ASIC's move away from a 'principles based approach that embeds appropriate flexibility' would negatively impact competition and cautioned that 'the broader economic and regulatory environment impacts the speed and availability of credit for consumers and should be considered as part of the review of RG209'.
ASIC has not yet made available a transcript of the public hearing held on 12 August. According to media reports, lenders (CBA and Westpac) reiterated concerns raised in submissions, including that the shift towards a more prescriptive approach would increase interest rates, reduce competition and expose banks to further disruption. Reportedly, Westpac CEO Brian Hartzer has previously commented that overly prescriptive regulators pose a risk to economic growth by curtailing bank's ability to lend to households and businesses.
Separately, ANZ CEO Shayne Elliott has also reportedly said that history had shown banks had done a 'pretty good job' with 'extremely few' customers negatively impacted. 'The economy works when you have reasonable access to credit and people can make mistakes and start businesses that sometimes will fail. That is an integral part of a well-functioning ... economy' he reportedly said.
Still a live issue?
(Possible) push for law reform?
The Financial Services Royal Commission's Final Report made no express recommendation to ban the use of the Household Expenditure Measure (HEM) or the use of other benchmarks to verify prospective borrowers’ ability to service a loan. However, Commissioner Hayne noted with approval the shift by industry away from using such benchmarks. ‘I consider…steps taken by banks to strengthen their home lending practices and to reduce their reliance on the HEM – are being taken with a view to improving compliance with the responsible lending provisions of the NCCP Act’.
Noting the decision above was then still pending, he added that should this interpretation of the content of the obligation be successfully challenged, that the law should be altered. 'If the court processes were to reveal some deficiency in the law’s requirements to make reasonable inquiries about, and verify, the consumer’s financial situation, amending legislation to fill in that gap should be enacted as soon as reasonably practicable'.
The AFR suggests that in light of Commissioner Hayne's comments, ASIC has 'no option' but to push for legislative reform 'such that the regulator’s view of responsible lending is better reflected in the law of the land'.
Only limited clarity?
Other media reports suggest that the decision is welcome because it provides a measure of clarity for lenders (and the regulator), some reports have described it as a 'win for common sense' on the basis that 'it should be up to individual lenders to decide how they assess a borrower’s repayment capacity'.
A number of reports observe that ASIC has not ruled out appealing the decision, and is yet to finalise its updates on responsible lending guidance and that the boundaries of responsible lending obligations are yet to be settled.